2003 Ruling 2003-0047713 - POSTAMBLE INTEREST PART X111

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: whether postamble of 212(1) (b) applies?

Position: No

Reasons:

Based on the particular fact situation. Although the Applicable Margin payable after the Trigger Date employs a variable that is the result of a formula of debt to EBITDA, these extra amounts payable simply use EBITDA as a tool to assess creditworthiness. As the borrower becomes more profitable, its payments decrease; this reflects the opposite of participating debt. Considering the modern rule of statutory interpretation and the apparent purpose of paragraph 212(1)(b), we are of the view that the phrase "computed by reference to" revenue, profit, cash flow, commodity price or any other similar criterion, has a somewhat narrower meaning in the context of the postamble of 212(1)(b) than it may bear in other sections of the Act.

XXXXXXXXXX 							2003-004771

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above taxpayer, as well as your letter of XXXXXXXXXX.

To the best of your knowledge and that of the taxpayers involved, the proposed transactions will not impact the ability of the taxpayers involved to pay their existing tax liabilities.

To the best of your knowledge and that of the taxpayers involved, none of the issues contained in this ruling request are:

(i) dealt with in an earlier return of the taxpayers or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers or a related person;

(iii) under objection by the taxpayers or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

DEFINITIONS

In this letter, the following terms have the meanings specified:

(a) "ABR" has the meaning set out in Paragraph 9;

(b) "Acquisitionco" means XXXXXXXXXX a corporation incorporated under the CBCA by certificate of incorporation dated XXXXXXXXXX, having its head office in XXXXXXXXXX. Acquisitionco is a wholly-owned subsidiary of Parentco, a private corporation, and a taxable Canadian corporation. The business number of Acquisitionco is XXXXXXXXXX It is resident within the jurisdictions of the XXXXXXXXXX TSO and the XXXXXXXXXX TC;

(c) "Act" means the Income Tax Act, R.S.C. 1985 (5th Suppl.) c.1, as amended to the date hereof, and unless otherwise stated, a reference herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act and the regulations thereunder are referred to as the "Regulations";

(d) "Borrowers" means Acquisitionco and Partnership;

(e) "CBCA" means the Canada Business Corporations Act, as amended;

(f) "CCRA" means the Canada Customs and Revenue Agency;

(g) "Closing" means the date on which the acquisition of the Vendor Business is completed;

(h) "Commitment Letter" means the credit facilities commitment among Parentco, inter alia, and the Lenders, as described in Paragraphs 4 and 5;

(i) "Consolidated EBITDA" means, for any period, the sum (without duplication) of the amounts for such period of Adjusted Net Income, plus (a) in each case to the extent deducted in calculating such Adjusted Net Income (except for clause (viii) below which is not reflected in Adjusted Net Income), (i) income tax expense, (ii) Consolidated Interest Expense, (iii) depreciation and amortization expense, (iv) nonrecurring costs and expenses not to exceed Cdn $XXXXXXXXXX incurred in connection with the Transactions within XXXXXXXXXX days thereof, (v) non-cash write-offs and impairment charges related to goodwill, intangibles and long-lived assets, (vi) write-offs of the step-up of inventory to fair market value in accordance with purchase accounting, (vii) non-cash compensation charges, (viii) the benefit (or to the extent not already deducted in computing Adjusted Net Income, the loss) of fair market value amounts ascribed to foreign currency hedging contracts in purchase accounting in the period in which the underlying contract is scheduled to be closed out, (ix) Transition Costs, (x) fees and expenses payable pursuant to the Investor Agreements, and (xi) other non-cash items of expense, other than to the extent requiring an accrual or reserve for future cash expenses all as determined on a consolidated basis for the Consolidated Companies, minus (b) (i) changes in estimates to reserves established in purchase accounting prior to the Transactions, and (ii) to the extent included in determining such Consolidated Net Income, all non-cash items of income for such period, other than changes in revenue estimates in the ordinary course of business and reduction in reserves that were not added back pursuant to clause (a)(xi) above, all determined on a consolidated basis in accordance with GAAP...

(j) "Credit Agreement" means the credit agreement to be executed by, inter alia, Acquisitionco, the Partnership and US Holdco, as borrowers, and the Lenders, which will include the terms and conditions governing the Term Loan Facility;

(k) "Lender #1" means XXXXXXXXXX;

(l) "Lender #2" means XXXXXXXXXX;

(m) "Lenders" means a syndicate of financial institutions which will provide the Term Loan Facility to Acquisitionco and the Partnership including XXXXXXXXXX;

(n) "LIBOR" has the meaning set out in Paragraph 9;

(o) "Newco" means XXXXXXXXXX, a corporation incorporated under the CBCA and a wholly-owned subsidiary of Acquisitionco. The business number of Newco is XXXXXXXXXX;

(p) "Paragraph" means a numbered paragraph in this advance income tax ruling;

(q) "Parentco" means XXXXXXXXXX. The business number of Parentco is XXXXXXXXXX.

(r) "Partnership" means XXXXXXXXXX, a partnership formed under the laws of XXXXXXXXXX, the sole partners of which are Acquisitionco and Newco;

(s) "Private corporation" has the meaning assigned by subsection 89(1);

(t) "Proposed transactions" means the transactions described in Paragraphs 6 to 9;

(u) "Taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(v) "TC" means Taxation Centre;

(w) "Term Loan Facilities" means the secured Canadian Term Facility and the U.S. Term Facility, each maturing on the XXXXXXXXXX anniversary of Closing, to be made available to Acquisitionco and the Partnership respectively at Closing by the Lenders, in an aggregate principal amount of Cdn $XXXXXXXXXX to finance the acquisition of the Vendorco Business;

(x) "Term Sheet" means Exhibit A to the Commitment Letter entitled "Senior Secured Credit Facilities - Summary of Terms and Conditions";

(y) "TSO" means Tax Services Office;

(z) "US Holdco" means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX , which is a wholly-owned subsidiary of Acquisitionco;

(aa) "Vendorco" means XXXXXXXXXX;

(bb) "Vendorco Business" means the XXXXXXXXXX; and

(cc) "Vendorco Foreign Business" means the shares of XXXXXXXXXX.

STATEMENT OF FACTS

1. On XXXXXXXXXX, Parentco executed a binding letter of intent pursuant to which it agrees to acquire (together with one or more of its wholly owned subsidiaries) the Vendorco Business for a consideration of Cdn $XXXXXXXXXX, subsequently renegotiated to Cdn $XXXXXXXXXX. This letter of intent was accepted by Vendorco on the same date. The parties are currently negotiating a definitive purchase and sale agreement pursuant to which Acquisitionco, a wholly-owned subsidiary of Parentco, and certain other subsidiaries of Acquisitionco, will acquire from Vendorco all of the capital stock of the companies which contain the Vendorco Business. The Closing of the acquisition is expected to occur no later than XXXXXXXXXX.

2. The acquisition of the Vendorco Business will be financed, in part, by borrowings made by Acquisitionco and the Partnership under the Term Loan Facilities provided for in the Credit Agreement (the "Credit Agreement") and made available by the Lenders at Closing in an aggregate principal amount of Cdn $XXXXXXXXXX.

3. A substantial portion of the Term Loans will be disbursed at closing by the Lenders to Acquisitionco. However, a portion of the Term Loans to be determined by Acquisitionco and the lead arrangers under the Term Loan Facilities, will be borrowed, at Closing, by the Partnership. The Term Loan provided to the Partnership will be used to fund the purchase price payable by US Holdco to acquire the Vendorco Foreign Business.

4. Pursuant to the Commitment Letter, Lenders have each committed to provide XXXXXXXXXX% of the amount that may be borrowed under the Term Loan Facilities. Lender #1 and Lender #2 are non-residents of Canada for purposes of the Act.

5. The Commitment Letter provides that the Lenders reserve the right and intend, prior to or after the execution of the Credit Agreement, to syndicate all or a portion of their commitments to one or more financial institutions. It is expected that commitments in respect of the Term Loan Facilities may be syndicated to financial institutions, which will be non-residents of Canada for purposes of the Act.

PROPOSED TRANSACTIONS

6. Acquisitionco will execute the Credit Agreement with the Lenders at Closing.

7. The Term Loans to be provided to Acquisitionco and the Partnership will be structured in order to comply with the requirements of the withholding tax exemption described in subparagraph 212(1)(b)(vii) of the Act.

8. The Credit Agreement will provide that the interest rate applicable to borrowings under the Term Loans will either be (i) U.S. Base Rate or U.S. Prime Rate (as defined in the Credit Agreement) (respectively the "US Base Rate Loans" and the "US Prime Rate Loans") plus the Applicable Margin, or (ii) LIBOR (as defined in the Credit Agreement) ("LIBOR Loans") plus the Applicable Margin.

The Applicable Margin will be XXXXXXXXXX% per annum for a US Base Rate Loan or a US Prime Rate Loan and XXXXXXXXXX% per annum for a LIBOR Loan.

However, after the Trigger Date (as defined in the Credit Agreement), the Applicable Margin will vary according to a grid based on Acquisitionco's most recent Total Leverage Ratio determined as of the most recent Calculation Date (i.e., the end of the most recent quarter, the first such Calculation Date being the last day of the first fiscal quarter) of Acquisitionco ended at least XXXXXXXXXX months after Closing. The Total Leverage Ratio on a particular date is the ratio of Total Debt as of the most recent Calculation Date to Consolidated EBITDA for the four Quarters ending on that particular Calculation Date.

The grid will specify several ranges for Acquisitionco's Total Leverage Ratio and a corresponding Applicable Margin for the Term Loans.

While the negotiation of the definition of Applicable Margin and in particular, the number of basis points applicable in respect of each range of the Total Leverage Ratio and the determination of the ranges, has not been completed, it is contemplated that the differential between the Applicable Margin in respect of the lowest range and the Applicable Margin in respect of the highest range is not likely to exceed XXXXXXXXXX basis points, with the lowest Applicable Margin being that which applies when the Total Leverage Ratio is the lesser amount. In other words, the Applicable Margin will decrease as the Total Leverage Ratio decreases. In general, as the Total Leverage Ratio increases from one range to the next, the Applicable Margin will increase by a specified percentage. Conversely, if the Total Leverage Ratio declines to a lower range, the Applicable Margin will decrease by a specified percentage. Indeed, the Applicable Margin may vary from one quarter to the next even though there is no change in EBITDA (i.e. there is a change only in the Total Debt of the Consolidated Companies). This grid will create a situation inverse to the one that would be created under a participating debt arrangement. Under a participating debt arrangement, the interest rate payable to the lenders would increase with revenue, profit, cash flow, commodity price, or a similar criterion of the borrower. However, in this case, the Applicable Margin will decrease as Acquisitionco's EBITDA increases.

The grid contemplated by the Commitment Letter and the Credit Agreement will result in an increase in Acquisitionco's cost of funds as its borrowing capacity declines, and allow Acquisitionco to benefit from a reduced interest rate margin as its borrowing capacity increases. This adjustment basis serves as a credit assessment mechanism by compensating the Lenders for a decline in the creditworthiness of Acquisitionco as its total debt increases or its earnings deteriorate. It does not provide the Lenders with a participation in the revenue, cash flow or profits of Acquisitionco.

9. The applicable terms of the Credit Agreement which are relevant to the Applicable Margin are summarised in paragraph XXXXXXXXXX of the Term Sheet as follows:

XXXXXXXXXX.

ADDITIONAL INFORMATION

10. It should be assumed that, except for the issue which is the object of the present advance income tax ruling request, all other requirements for the application of the withholding tax exemption provided in subparagraph 212(1)(b)(vii) of the Act are satisfied.

PURPOSE OF THE PROPOSED TRANSACTIONS

11. The purpose of the proposed transaction is to finance Acquisitionco's acquisition of the Vendorco business.

The purpose of the provision of the Credit Agreement which will permit the interest rate applicable to the Term Loans to vary based on Acquisitionco's Total Leverage Ratio is:

(i) to allow Acquisitionco's cost of financing to be reduced if its financial performance, as measured by the Total Leverage Ratio, improves after Closing, and

(ii) to allow the Lenders to earn a greater return on the Term Loans if Acquisitionco's creditworthiness (and therefore, the Lenders' credit risk), as measured by the Total Leverage Ratio, deteriorates after Closing.

RULING

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant warranties on page 1 of this advance income tax ruling, as well as all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our ruling is as set forth below:

The use of the Applicable Margin described in Paragraphs 8 and 9 will not, in and of itself, cause the postamble of paragraph 212(1)(b) to apply to deem payments made under the Term Loans not to be interest described in subparagraph 212(1)(b)(vii).

CAVEAT

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 (the "Circular") issued by the CCRA on May 17, 2002, and are binding provided the Proposed Transactions above are completed on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act.

Nothing in this letter should be construed as implying that the CCRA has agreed to or accepted:

(i) the GST implications of any of the proposed transactions;

(ii) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein, and in particular, whether the proposed transactions fall within the ambit of subparagraph 212(1)(b)(vii) of the Act.

Yours truly,

XXXXXXXXXX
for Director
Financial Industries Division
Income Tax Rulings Directorate